Last updated: Mar-18-2019

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Veteran business journalist and investigative reporter Olev Edur takes you behind the performance numbers for close-up look at the people, processes, and portfolios that make investment funds tick.

By Olev Edur  | Tuesday, January 31, 2017

Last year turned into a rough haul for most real estate equity funds, following several years of double-digit returns. While the category’s 3- and 5-year average annual compounded returns through December 2016 were 11.0% and 12.1% respectively, calendar 2016 returns averaged a paltry 1.0%, and the last six months of the year saw real estate equity funds lose -1.1%. So what happened and, more importantly from an investor’s perspective, what does this downturn bode for the future of real estate?

Is the recent flagging performance the start of a cyclical and perhaps extended downturn, or just a blip in an otherwise upward trend? And how can investors best capitalize on whichever scenario ensues?

I spoke recently with Chip McKinley, senior vice-president at New York, NY-based money manager Cohen & Steers, and sub-advisor to one of the top-performing Canadian funds in the Real Estate Equity sector, United Real Estate Investment Pool Class A. (The fund is available through CI Investments’ subsidiary Assante Wealth Management, and is administered by CI Investments Inc.) According to McKinley, the downturn was indeed a temporary aberration. “After a healthy total return in 2012, decent returns in 2013, and a very strong 2014, the market started going sideways in 2015 and turned negative in mid-2016,” he said, adding, “This was a global phenomenon, although it was probably worse in the U.S.”

“There were a couple of factors [behind the downturn],” McKinley explains. “First there were growing signs of accelerating economic growth, particularly in the U.S. but also in Europe and Japan. Inflation was rising, and it’s ironic that increasing expectations of economic growth and inflation had a negative impact on real estate, at least in the short term.

“If you look at risk-free Treasurys, yields all went up in 2016, and [Federal Reserve chair Janet] Yellen set the stage for further increases in 2017,” McKinley says. “That sent the value of all yield-generating assets down, and real estate is a category that shares the characteristics of both fixed income and equity investments. Normally, real estate is like equities in that it can generate real per-share earnings growth, but like bonds, real estate is also a yielding investment. If interest rates spike, as they did last year, investors mark down prices.

“That was actually a good thing, though,” McKinley adds. “I think it sets up moderately strong underlying fundamentals for many companies. It should result in cash flow growth for shares, and some scope for multiples to increase. That should lead to healthy total returns for the next one or two years at least. We’re more bullish than we’ve been in the last couple of years.”

As for how best to capitalize, McKinley intends to continue applying a fundamental, bottom-up valuation process based on rigorous in-depth research using a dividend discount model (measuring the present future value of future cash flow) as well a net asset value approach (appraising the value of properties). “Those are the two main valuation metrics, and both are equally important, but when you combine them both, it’s a much more powerful tool.”

McKinley applies the measurements to find “the best real estate companies wherever we find them globally,” he says. “These companies give us a very broad set of investment opportunities, so we can diversify very significantly, while seeking strong recurring income and regular growth from rent, occupancy, and property values.

“For example, we can target offices in Australia, or hotels in Tokyo, or shopping malls in London,” McKinley adds. “They’re not correlated, so as one kind of property reaches its peak and generates maximum returns for that type of investment, we can rotate from those that are now fully valued to those that are at the bottom on their trough.”

At the end of December, the fund had allocated 51.5% to U.S. equities, including Simon Property Group (NYSE: SPG), SL Green Realty Corp. (NYSE: SLG), and Red Rock Resorts Inc. (NASDAQ: RRR). Another 38.3% was devoted to international equities, including Tokyo Tatemono Co. Ltd. (TYO: 8804), Klepierre SA (EPA: LI), and Mitsui Fudosan Co Ltd. (TYO: 8801).

It’s the same approach that, notwithstanding this latest blip, enabled the United Real Estate Investment Pool to generate 3- and 5-year average annual compound returns of 11.9% and 13.4% respectively through Dec. 31, 2016 – one of the best performances in the real estate equity category.

Olev Edur is an experienced financial and business journalist and a frequent contributor to the Fund Library.

Notes and Disclaimers

© 2017 by Fund Library. All rights reserved. Reproduction in whole or in part by any means without written permission is prohibited.

Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the simplified prospectus before investing. Mutual funds are not guaranteed and are not covered by the Canada Deposit Insurance Corporation or by any other government deposit insurer. There can be no assurances that the fund will be able to maintain its net asset value per security at a constant amount or that the full amount of your investment in the fund will be returned to you. Fund values change frequently and past performance may not be repeated. No guarantee of performance is made or implied. The foregoing is for general information purposes only. This information is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting or tax advice.

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